China - taking stock

The economy is still recovering from the lockdowns of April and May, and that recovery likely still has some room to run. But it feels like downside risks are now growing again. This week's export and monetary data will be useful in evaluating just how large those risks are.

Cycle summary

The short-term picture for China features an economy that has escaped the worst of the recent Covid-19 problems, but not all them. With macro policy easing also constrained, that is translating into an economic recovery from the lockdowns of April and May that is clear but modest. This picture makes it more difficult for the property market to recover, which in turn further hinders the overall recovery, and raises financial risks. With inflation low and likely to fall further, the macro backdrop dampens any rise in interest rates, and in the short-term at least, keeps upwards pressure on $CNY.


There's four obvious risks that could disrupt this short-term picture. On the downside, there's the risk of another covid outbreak that triggers a big new lockdown. The current recovery could also run out of steam, as the momentum from an easing of lockdowns runs into the continuing issues in property, and an export cycle that is starting to look shakier. On the upside, the property easing of the last few months could start to feed through into a more obvious recovery. Or policy stimulus could be stepped up, and altered to include real help for consumers.

The next few days will provide some more colour on how the balance between these different risks is shifting. In this, likely less significant will be the Q2 GDP data on Friday than the monetary and export data for June. While not the only thing that matters, credit growth is an important manifestation of macro easing. As for exports, data for elsewhere in the region are starting to look shakier. That matters for China, given the role that external demand played in pulling the economy out of the lockdown-induced recession of 2020.

Xi Jinping a couple of weeks ago did promise “more forceful measures” to achieve this year's growth targets, and it still seems likely that policymakers will come to the realisation that something bigger and different needs to be done. However, if and until that happens, it feels as if downside risks will be growing again.

Recent developments

Economic recovery. With the ending of the lockdown in Shanghai and an improvement of the situation in Beijing, economic activity continues to improve. Shanghai last week reopened cinemas and passenger numbers using subways have risen quite a lot. Nationally, the Caixin services PMI bounced to 54.5 in June, and non-official surveys suggest a decent improvement in consumer confidence last month.

Zero covid. But, as long as there is a commitment to zero covid, the threat of a big outbreak will continue to cast a shadow over economic prospects. The authorities did manage to push the national case count down to just 23 by late June. But since then, it has bounced back to above 300. The latest hotspot is Anhui, an important manufacturing province neighbouring the east coast. The authorities there have responded with localised lockdowns.

Incremental stimulus. The premier Li Keqiang last week was in Fujian province to discuss the economy, together with officials from Shanghai, Zhejiang, Jiangsu and Guangdong. This is significant in the sense that these five local governments together oversee the most economically dynamic region of China, and so the meeting shows – as if we needed reminding – that Li remains concerned about the cycle. The premier was quoted as saying that “the foundation for recovery is still unstable and arduous efforts will be required to stabilise the economy”. But he's been saying similar things in recent weeks, and so far at least, no new initiatives were forthcoming from the Fujian meeting.

There have been reports that having pushed local governments to fulfil all their 2022 quota for special bond issuance by the end of June, the central government will now allow them to utilise some of their (so far unannounced) 2023 quota in the second half of this year. That will provide a bit more fiscal stimulus this year. The funds have to be used for revenue-generating projects, which tend to be more infrastructure related. But in the past, there hasn't been a strong relationship between these bond issues and overall investment spending. And as they have to be tied to revenue-generating projects, there's little room to hope for a rebalancing of the current policy focus away from companies and capex towards consumers and consumption.

Contained inflation. Data published over the weekend showed average real economy inflation easing again in June. There might be some upside risks from food prices, but for PPI and core CPI, the leads continue to suggest that inflation will moderate further from here. That gives the government more room to ease monetary policy further, though a continued easing of PPI is also likely to dampen profitability of China's corporate sector.

Financial risks. There are signs of a revival of end-user demand for property, but at least so far, that's not translating into much easing of the financial stress on developers. That stress is more focused on private sector developers, with some in the industry claiming there is a “natural” discrimination against firms that don't have state backing. In a different context to China, that bias would probably be considered “unnatural”; anyway,  equity and debt performance for homebuilders as a whole is back at the lows.

In addition, problems with local banks in Henan have come to the fore with quite visible demonstrations against the local branch of the People's Bank of China. It isn't clear that the issues in Henan relate to the same macro issues that the country as a whole is facing. But still, with land sales and the economy weak, local governments have less money to paper over any financial cracks than they once did.